Chapter 8 Critical Thinking Case 2 The Jennings Want to Know: How Much Is Enough
ID: 2794096 • Letter: C
Question
Chapter 8
Critical Thinking Case 2
The Jennings Want to Know: How Much Is Enough?
Darrell and Lena Jennings are a two-income couple in their early 30s. They have two children, ages 6 and 3. Darrell's monthly take-home pay is $3,600, and Lena's is $4,200. The Jennings feel that, because they're a two-income family, they both should have adequate life insurance coverage. Accordingly, they are now trying to decide how much life insurance each one of them needs.
To begin with, they'd like to set up an education fund for their children in the amount of $120,000 to provide college funds of $15,000 a year - in today's dollars - for four years for each child. Moreover, if either spouse should die, they want the surviving spouse to have the funds to pay off all outstanding debts, including the $210,000 mortgage on their house. They estimate that they have $25,000 in consumer installment loans and credit cards. They also project that if either of them dies, the other probably will be left with about $10,000 in final estate and burial expenses.
Regarding their annual income needs, Darrell and Lena both feel strongly that each should have enough insurance to replace her or his respective current income level until the youngest child turns 18 (a period of 15 years). Although neither Darrell nor Lena would be eligible for Social Security survivor's benefits because they both intend to continue working, both children would qualify in the (combined) amount of around $1,800 a month. The Jennings have accumulated about $75,000 in investments, and they have a decreasing term life policy on each other in the amount of $100,000, which could be used to partially pay off the mortgage. Darrell also has an $80,000 group policy at work and Lena a $100,000 group policy.
Assume that Darrell's gross annual income is $54,000 and Lena's is $63,000. Their insurance agent has given them a multiple earnings table showing that the earnings multiple to replace 75 percent of their lost earnings is 8.2 for Darrell and 7.3 for Lena. Use this approach to find the amount of life insurance each should have if they want to replace 75 percent of their lost earnings.
Life insurance needed by Darrell: $
Life insurance needed by Lena: $
Use Worksheet 8.1 to find the additional insurance needed on both Darrell's and Lena's lives. (Because Darrell and Lena hold secure, well-paying jobs, both agree that they won't need any additional help once the kids are grown; both also agree that they'll have plenty of income from Social Security and company pension benefits to take care of themselves in retirement. Thus, when preparing the worksheet, assume "funding needs" of zero in Periods 2 and 3.)
Additional insurance needed by Darrell $
Additional insurance needed by Lena $
Is there a difference in your answers to Questions 1 and 2? If so, why? Which number do you think is more indicative of the Jennings' life insurance needs? Using the amounts computed in Question 2 (employing the needs approach), what kind of life insurance policy would you recommend for Darrell? For Lena? Briefly explain your answers.
Chapter 8
Financial Planning Exercise 1
Estimating life insurance needs
Use Worksheet 8.1 Katie Holt is a 72-year-old widow who has recently been diagnosed with Alzheimer's disease. She has limited financial assets of her own and has been living with her daughter Laurie for 2 years. Her only income is $600 a month in Social Security survivor's benefits. Laurie wants to make sure her mother will be taken care of if Laurie should die. Laurie, 40, is single and earns $60,000 a year as a human resources manager for a small manufacturing firm. She owns a condo with a current market value of $110,000 and has a $64,000 mortgage. Other debts include a $3,500 auto loan and $400 in various credit card balances. Her 401(k) plan has a current balance of $65,000, and she keeps $5,500 in a money market account for emergencies. After talking with her mother's doctor, Laurie believes that her mother will be able to continue living independently for another 3 years. She estimates that her mother would need about $1,650 a month to cover her living expenses and medical costs during this time. After that, Laurie's mother will probably need nursing home care. Laurie calls several local nursing homes and finds that it will cost about $3,500 a month when her mother enters a nursing home. Her mother's doctor says it is difficult to estimate her mother's life expectancy but indicates that with proper care some Alzheimer's patients can live 10 years after diagnosis. Laurie also estimates that her personal final expenses would be around $13,000, and she'd like to provide a $35,000 contingency fund that would be used to pay a trusted friend to supervise her mother's care if Laurie were no longer alive. Use Worksheet 8.1 to calculate Laurie's total life insurance requirements. In your analysis, assume an incidental special need amount of $13,000.
$
Recommend the type of policy she should buy. In your analysis, assume an incidental special need amount of $13,000.
Explanation / Answer
Answer a)
Using the earnings multiple calculation, the Jennings’ insurance needs are:
Darrell: ($3,600 * 12 = $43,200) * 8.2 = $354240
Lens: $(4,200 * 12 = $50,400) * 7.3 = $367920
Answer b)
Life Insurance Needs Analysis Method
Insured Name :- Lena Jennings Dated 5/5/2016
Life Insurance Needed Analysis Method
Darrell Jennings
Total Financial Resources Needed as calculated above are same :- $1769000
The worksheets are above. One assumption is that the decreasing term that they each have pays $100,000 at the death of the insured. Since it is decreasing term that is most likely overstating the amount of insurance that will be received by the survivor.
The worksheet results suggest that Darrell needs to have insurance on his life of $434,000, which because of the decreasing term, should be rounded to $500,000.
The worksheet results suggest that Lena needs to have insurance on his life of $522,000, which because of the decreasing term, should be rounded to $600,000.
c)
One difference is that the earnings multiple calculation is designed to replace 75% of the lost income. In the Worksheet analysis, the assumption is that 100% of the income is needed. Also, the worksheet is a more specific needs analysis than the general earnings multiple calculation. The more specific analysis provided by the worksheet is the better measure of their insurance needs.
The insurance needs are for a specific period of 15 years, until the children completes college. After that time, they believe that their income and retirement income will be sufficient and they will need no additional insurance. This is a case for term insurance. The best insurance for the premium dollar is level premium term for their time of need (15 years). So I would recommend term insurance for both Darrell and Lena.
Answer 2)
Financial Resources needed after Death
Period 1 Period 2 Period 3
Monthly living Exp 1650 3500
Net yearly Income 19800 42000
No of years 3 10
Total living need 59400 420000 =479400
Other needs 35000
Final exp 13000
House mortgage 64000
Other Loans 3900 67900
Total financial resources needed 595300
Period 1 Period 2
Annual Social Security (600 x12) 7200 7200
No of years 3 10
Total Income 21600 72000 = 93600
Savings & Investments (65000+5500 ) =70500
Other =110000
Total Financial resources available 274100
Needed 595300
Available 274100
additional 321200
Laurie is concerned that she should die and leave her mother not able to get the care she needs. While it is difficult to estimate lives, Laurie believes that her mother will live no more than 13 additional years. At Laurie’s death, Katie [Mother] will only have her social security which does not cover her expenses now. The needs analysis, Worksheet 8.1 below, indicates that Laurie will need $321200 of additional life insurance to provide for her mother’s care for the rest of her life. Laurie is 40 now.
Given Laurie’s middle age and the need for insurance of only an additional 13 years, Laurie should purchase 15 year term life insurance. After her mother dies, she will no longer have need for life insurance. With 15 year term, the premiums will be fixed for 15 years.
If Laurie does not die, she will have to find funds to cover her mother’s costs. Perhaps the mother will qualify for Medicaid given her Alzheimer’s disease.
Step 1 Financial Resources needed after Death 1 Annual Living Expenses and other needs Period 1 Period 2 Period 3 a Monthly living exp $ 7800 b Net Yearly Income need ( a * 12) $ 93600 $ $ c Number of Years in Time period 15 d Total living need per time (b * c) 1404000 - - Total Living Expenses 1404000 2 Special Needs a Spouse Education Fund b Childrens College Fund 120000 c Other needs 3 Final Expenses Funeral,estate costs 10000 4 Debt Liquidation a House Mortgage 210000 b Other Loans 25000 c Total Debt 235000 5 Other Fianncial Needs Total Financial Resources Needed 1769000 Step 2 Financial Resources available after death 1 Income Period 1 Period 2 Period 3 a Annual Social Security Survivors 21600 b Surviving Spouse Annual Income 43200 c Other Annual Pensions d Annual Income 64800 e No of yrs 15 f Total Period Income 972000 g Total Income 972000 2 Savings and Investments 75000 3 Other life Insurance 100000 4 Other Resources 100000 Total Financial Resources Available 1247000 Total Financial Resources Needed 1769000 Total Financial Resources Available 1247000 Additional Life Insurance Needed 522000
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